Shrinking Revenues and Uncertain Federal Funding Loom
States face some uncertainty with every budget proposal, but several unusual factors are converging to make FY 2026 a fiscal challenge.
Pandemic-Era Funding Is in the Rearview Mirror
Most states had several consecutive years of revenue surpluses after the COVID-19 pandemic, partly from federal stimulus packages. These federal dollars and surpluses, which helped fund new programs and bulked up rainy-day reserves, are now fully spent or off the books for the majority of states.
Some governments invested that money wisely into stabilization funds. Others used it to launch programs they may no longer be able to sustain without federal support. Either way, FY 2026 marks a somewhat expected pivot point.
Federal Funding Cuts Appear Imminent
Congress is eyeing $1.5 trillion in cuts over 10 years, and Medicaid and potentially education are on the chopping block. Since these two categories compose the lion’s share of most state budgets, any change in funding could force states to either spend more from their own coffers or make politically risky cuts.
Additionally, agencies such as the Federal Emergency Management Agency and the Cybersecurity and Infrastructure Security Agency face budget cut proposals. The Trump administration recently proposed a $216 million cut, or 18% of current funding, from CISA’s Cybersecurity Division in 2026. The agency provides no-cost resources for securing critical infrastructure to all 50 states.
Federal grants are also in jeopardy. Digital equity grants are already being terminated, and some federal grants such as the Broadband Equity, Access and Deployment Program grant may change in form. The State and Local Cybersecurity Grant Program (SLGCP) also faces a somewhat uncertain future.
AI and IT Modernization Will Drive Efficiency
Gone are the days of 10% budget hikes fueled by pandemic money and high tax revenue. Most states will need to budget conservatively, perhaps anticipating 0%-3% year-over-year growth. States will also need to build flexibility into funding strategies.
Most states have already begun preparing by launching their own departments or committees dedicated to government efficiency. These include Texas, South Carolina, Iowa, Kansas, Missouri, Oklahoma, New Hampshire, Idaho, Florida, Wisconsin, Alabama, Maryland, Louisiana, New York, Georgia, North Dakota, Kentucky, South Carolina, Mississippi, North Carolina and Hawaii.
AI and IT modernization will be central to these efforts. In lean times, efficiency becomes everything. Some of the specific strategies that states will look at include:
- AI-powered chatbots for constituent services
- Automated back-end workflows
- Digitization of procurement or permitting systems
- Smarter cybersecurity across a whole-of-state model (Half of states use state-level oversight to create efficiencies and scale resources, especially with SLGCP funds still in play.)
If hiring slows or freezes, states may also rely more on third-party services to keep operations running. The goal will be to bring down costs as much as possible without degrading performance, and managed services might help fill gaps when turnover occurs — especially as more baby boomers retire.
AI will have a role to play in reducing staffing burdens in areas such as first-line response systems, citizen interaction portals and data management.
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Tech Will Carry States Through This Correction Phase
The past few years were atypical, defined by excess funding, high revenue and optimism. FY 2026 is not a collapse, just a return to a fiscal reality for states. In fact, many states are simply snapping back to the pre-pandemic slope. The challenge now is managing that correction with clarity and agility.
And that’s where technology — not just AI but managed services, collaborative cybersecurity and smarter IT infrastructure — will play a vital role.
